THE CASH FLOWS FOR AN ANNUITY DUE MUST ALL OCCUR AT THE BEGINNING OF THE PERIODS.

13 Jun THE CASH FLOWS FOR AN ANNUITY DUE MUST ALL OCCUR AT THE BEGINNING OF THE PERIODS.

This exam consist of 25 multiple choice questions and covers the material in Chapters 4 through 7.
Which of the following statements is CORRECT?
Answer

If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.

The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.

If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.

The cash flows for an annuity due must all occur at the beginning of the periods.

The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month.
Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?
Answer

$205.83

$216.67

$228.07

$240.08

$252.08
Your bank account pays a 5% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?
Answer

The periodic rate of interest is 5% and the effective rate of interest is also 5%.

The periodic rate of interest is 1.25% and the effective rate of interest is 2.5%.

The periodic rate of interest is 5% and the effective rate of interest is greater than 5%.

The periodic rate of interest is 1.25% and the effective rate of interest is greater than 5%.

The periodic rate of interest is 2.5% and the effective rate of interest is 5%.
At the end of 10 years, which of the following investments would have the highest future value? Assume that the effective annual rate for all investments is the same and is greater than zero.
Answer

Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).

Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).

Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).

Investment D pays $2,500 at the end of 10 years (just one payment).

Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).
Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures?
Answer

$3,754.27

$3,941.99

$4,139.09

$4,346.04

$4,563.34
You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?
Answer

The discount rate increases.

The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.

The discount rate decreases.

The riskiness of the investment’s cash flows increases.

The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.
Which of the following statements is CORRECT?
Answer

All else equal, long-term bonds have less interest rate price risk than short-term bonds.

All else equal, low-coupon bonds have less interest rate price risk than high-coupon bonds.

All else equal, short-term bonds have less reinvestment rate risk than long-term bonds.

All else equal, long-term bonds have less reinvestment rate risk than short-term bonds.

All else equal, high-coupon bonds have less reinvestment rate risk than low-coupon bonds.
Which of the following statements is NOT CORRECT?
Answer

All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.

If a bond is selling at its par value, its current yield equals its yield to maturity.

If a bond is selling at a premium, its current yield will be greater than its yield to maturity.

All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.

If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.
Which of the following statements is CORRECT?
Answer

If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.

Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.

Reinvestment rate risk is worse from an investor’s standpoint than interest rate price risk if the investor has a short investment time horizon.

If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value

Which of the following statements is CORRECT?
Answer

Liquidity premiums are generally higher on Treasury than corporate bonds.

The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.

Default risk premiums are generally lower on corporate than on Treasury bonds.

Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?
Answer

One year from now, Bond A’s price will be higher than it is today.

Bond A’s current yield is greater than 8%.

Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.

Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.

Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.
An 8-year Treasury bond has a 10% coupon, and a 10-year Treasury bond has an 8% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?
Answer

Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

The prices of both bonds would increase by the same amount.

One bond’s price would increase, while the other bond’s price would decrease.

The prices of the two bonds would remain constant.

The prices of both bonds will decrease by the same amount.
Which of the following statements is CORRECT?
Answer

If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par.

All else equal, if a bond’s yield to maturity increases, its price will fall.

If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.

All else equal, if a bond’s yield to maturity increases, its current yield will fall.

A zero coupon bond’s current yield is equal to its yield to maturity

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?
Answer

If a stock’s beta doubled, its required return under the CAPM would also double.

If a stock’s beta doubled, its required return under the CAPM would more than double.

If a stock’s beta were 1.0, its required return under the CAPM would be 5%.

If a stock’s beta were less than 1.0, its required return under the CAPM would be less than 5%.

If a stock has a negative beta, its required return under the CAPM would be less than 5%.
Which of the following statements is CORRECT?
Answer

Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.

The beta of an “average stock,” which is also “the market beta,” can change over time, sometimes drastically.

If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.

During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

If a company with a high beta merges with a low-beta company, the best estimate of the new merged company’s beta is 1.0.
Which of the following statements is CORRECT?
Answer

The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.

An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks.

Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.

An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.
Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?
Answer

The required return on a stock with beta > 1.0 will increase.

The return on “the market” will remain constant.

The return on “the market” will increase.

The required return on a stock with beta < 1.0 will decline. The required return on a stock with beta = 1.0 will not change Which of the following statements is CORRECT? Answer Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full’s revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.’s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. Stock A’s beta is 1.7 and Stock B’s beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct. Answer In equilibrium, the expected return on Stock B will be greater than that on Stock A. When held in isolation, Stock A has more risk than Stock B. Stock B would be a more desirable addition to a portfolio than A. In equilibrium, the expected return on Stock A will be greater than that on B. Stock A would be a more desirable addition to a portfolio then Stock B. Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate? Answer 6.01% 6.17% 6.33% 6.49% 6.65% A share of Lash Inc.’s common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors’ required rate of return is 11.4%, what is the stock price? Answer $16.28 $16.70 $17.13 $17.57 $18.01 Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT? Answer If one stock has a higher dividend yield, it must also have a lower dividend growth rate. If one stock has a higher dividend yield, it must also have a higher dividend growth rate. The two stocks must have the same dividend growth rate. The two stocks must have the same dividend yield. The two stocks must have the same dividend per share. 2 points If a firm’s expected growth rate increased then its required rate of return would Answer decrease. fluctuate less than before. fluctuate more than before. possibly increase, possibly decrease, or possibly remain constant. increase. Merrell Enterprises’ stock has an expected return of 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? Answer The stock’s dividend yield is 8%. The current dividend per share is $4.00. The stock price is expected to be $54 a share one year from now. The stock price is expected to be $57 a share one year from now. The stock’s dividend yield is 7%. Which of the following statements is CORRECT? Answer If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%. The stock valuation model, P0 = D1/(rs  g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.